Market Regulation1 MARKET REGULATION Economics 2023 Principles of Microeconomics Dr. McCaleb

Market Regulation2 TOPIC OUTLINE I.Economic Analysis of Regulation II.Regulation and Public Interest

Market Regulation3 Economic Analysis of Regulation

Market Regulation4 ECONOMIC ANALYSIS OF REGULATION  Two Types of Market Regulation Economic regulation and social regulation Economic regulation is the traditional form of regulation. It is usually industry-specific. The deregulation movement of the last two decades has been primarily focused on reducing economic regulation of markets. Social regulation is a newer form of market regulation that grew up during the 20th century, mostly since the 1960’s. While economic regulation has been declining, social regulation has grown rapidly.

Market Regulation5 ECONOMIC ANALYSIS OF REGULATION  Economic Regulation of Markets Restrictions on entry, price, quantity, and market share Economic regulation limits entry into a market or sets prices, restricts quantities, and allocates market shares among sellers. While anti- trust policy is intended to open markets up to new competition, economic regulation limits competition. Examples of economic regulation that often limit competition include Public franchises Occupational licensing Other licensing requirements

Market Regulation6 ECONOMIC ANALYSIS OF REGULATION Market Effects of Economic Regulation If the taxi market is unregulated, the equilibrium number of taxis is 25,000 and the equilibrium average fare is $6. Consumer surplus, shown by the green triangle, is $125,000.

Market Regulation7 ECONOMIC ANALYSIS OF REGULATION Market Effects of Economic Regulation If the government limits the number of taxis to 12,500, the regulated supply, shown by the gold supply curve, is perfectly inelastic. Equilibrium price rises to $11 and quantity falls. A portion of consumer surplus, shown in blue, is transferred to taxi owners as producer surplus. Another portion is simply lost, a deadweight loss, shown in purple.

Market Regulation8 ECONOMIC ANALYSIS OF REGULATION  Social Regulation of Markets Regulations prescribing how products must be designed or how they must be produced Social regulation prescribes how products must be designed or how they must be produced or mandates the inclusion of specific features in the product. Social regulation includes health and safety regulations, environmental regulation, and occupational safety regulations.

Market Regulation9 ECONOMIC ANALYSIS OF REGULATION Market Effects of Social Regulation If the taxi market is unregulated, the equilibrium number of taxis is 25,000 and the equilibrium average fare is $6. Consumer surplus, shown by the green triangle, is $125,000.

Market Regulation10 ECONOMIC ANALYSIS OF REGULATION Market Effects of Social Regulation If the government mandates that all taxis have a partition separating drivers and passengers, operating cost increases as shown by the gold supply curve. Equilibrium price rises to $11 and quantity falls to 12,500. A portion of consumer surplus, shown in blue, is absorbed by the increase in cost. Another portion is simply lost, a deadweight loss, shown in purple.

Market Regulation11  Consequences of Market Regulation Regulation is inefficient Economic regulation Economic regulation has the same effects on efficiency as monopoly. Higher prices Smaller quantities Redistribution of consumer surplus from consumers to producers Deadweight loss. Because of the deadweight loss, economic regulation is inefficient. ECONOMIC ANALYSIS OF REGULATION

Market Regulation12  Consequences of Market Regulation Social regulation Social regulation results in: Higher prices Smaller quantities Increased cost to consumers and producers Deadweight loss. Because of the deadweight loss, social regulation is also inefficient. ECONOMIC ANALYSIS OF REGULATION

Market Regulation13  Consequences of Market Regulation Comparison of the market effects of economic regulation and social regulation Economic and social regulation have similar effects on the market: higher prices, smaller quantities, deadweight loss. Economic regulation redistributes some of the surplus remaining after the deadweight loss from consumers to producers but does not affect cost. Social regulation increases cost and reduces the total surplus remaining after the deadweight loss, but social regulation does not redistribute surplus from consumers to producers. ECONOMIC ANALYSIS OF REGULATION

Market Regulation14  Consequences of Market Regulation Additional effects of market regulation, economic and social Both economic and social regulation also Limit competition and consumer choice Impose administrative costs on society Have unintended consequences. ECONOMIC ANALYSIS OF REGULATION

Market Regulation15  Consequences of Market Regulation Limits competition and consumer choice By restricting entry, setting prices, and allocating market shares (economic regulation), and by prescribing how products must be designed or how they must be produced (social regulation), market regulation reduces the scope for sellers to compete with one another. When competition is limited, sellers have less incentive to use resources to satisfy consumer demand, to minimize cost, and to be innovative. When production is regulated and when regulation requires that goods include features that cost more than their value to consumers, regulation limits consumer choices and raises costs and prices. ECONOMIC ANALYSIS OF REGULATION

Market Regulation16  Consequences of Market Regulation Imposes administrative costs Regulation is costly to implement, administer, and enforce. It imposes costs on both taxpayers and on the regulated sellers. In competitive markets where long-run economic profits are zero, sellers cannot absorb the costs of regulation and still earn a normal profit on their investment. Therefore, the costs of regulation are ultimately passed on to consumers in higher prices. ECONOMIC ANALYSIS OF REGULATION

Market Regulation17  Consequences of Market Regulation Has unintended consequences Consumers come to rely on regulation to ensure product safety and quality. Consumers then take fewer actions of their own to provide for safety and quality even if they can do so more effectively and at less cost than sellers or the government. The result is that regulation has negative consequences that were unforeseen and unintended at the time the regulation was adopted. Even if the benefits of regulation are greater than the expected costs, the unexpected costs arising from the unintended consequences may outweigh regulation’s benefits. ECONOMIC ANALYSIS OF REGULATION

Market Regulation18 Regulation and Public Interest

Market Regulation19 REGULATION AND PUBLIC INTEREST  Regulation: Principle and Practice Regulation often benefits producers and regulators, not consumers In principle, regulation is supposed to improve consumer welfare. In practice, regulation often has negative effects on consumer welfare. Regulation often benefits the regulated businesses, special interest groups, and the regulators at the expense of consumers. Even when regulation does benefit consumers, the benefit to consumers is often less than the costs of the regulation. Even when the benefits to consumers are greater than the costs, regulation often has unintended consequences that harm consumers.

Market Regulation20 REGULATION AND PUBLIC INTEREST  Regulation: Principle and Practice Regulation often promotes the special interests rather than the public interest Special interest effect Regulation often isn’t even intended to promote the public interest or to benefit consumers, despite the rhetoric. The demand for regulation frequently comes from special interests seeking redistribution of wealth, not from consumers seeking greater economic efficiency. Special interests claim that regulation promotes the public interest but in fact it promotes their private interest.

Market Regulation21 REGULATION AND PUBLIC INTEREST  Regulation: Principle and Practice Because of the special interest effect, regulations are often adopted even when the total costs to consumers exceed the benefits. Why? The benefits are concentrated on a small number of individuals (the special interests) so that the benefit to each member of the special interest group is larger than the cost of lobbying for the regulation. The costs of the regulation are dispersed across a much larger number of consumers so that the cost of the regulation to each consumer is less than the cost to the consumer of lobbying against the regulation. Therefore, the special interests out-lobby and outspend consumers, and regulations that are inefficient and harmful to consumers are often adopted. This is another example of rent-seeking.

Market Regulation22 REGULATION AND PUBLIC INTEREST  Regulation: Principle and Practice Capture theory of regulation Even when the initial demand for regulation does in fact come from consumers, over time consumers lose interest. Control over the regulatory process passes from consumers to the regulated special interests. The special interests with the most to gain or lose from the regulation eventually “capture” or take control of the regulatory process.

Market Regulation23 REGULATION AND PUBLIC INTEREST  Regulation: Principle and Practice Regulators are themselves a special interest Regulation often promotes the self-interest of the regulators, especially where less regulation would narrow the scope of their authority or threaten their jobs. The regulators themselves are a special interest. For this reason, regulation is often inflexible, slow to respond to changes in consumer demand, market conditions, and technology, and not conducive to innovation.

Market Regulation24 REGULATION AND PUBLIC INTEREST  Markets as an Alternative to Regulation Markets and prices are often superior to regulation Even where the benefits of regulation are greater than the costs, markets and prices are often more effective and more efficient than regulation in promoting consumer interests and achieving socially desirable objectives. Markets and prices alter incentives, encouraging individuals to act in socially beneficial ways. Regulation imposes costs that only encourage individuals to waste scarce resources in an effort to avoid or circumvent the regulations.

Market Regulation25 REGULATION AND PUBLIC INTEREST  Unscientific Regulation Regulation is often based on unscientific analysis, misinformation, and faulty data The analysis, information, and data used to promote and support regulations are often unsound and unscientific. Unscientific analysis, misinformation, and faulty data are frequently used deliberately by special interests and by the regulators to promote their private agendas.

Market Regulation26 REGULATION AND PUBLIC INTEREST Example: Motorcycle Registrations and Fatalities in Helmet Law States and in Non-Helmet Law States Non-Helmet Law States Helmet- Law States Fatalities per 1000 accidents Fatalities per 10,000 registered motorcycles Motorcycle registrations per 1000 population Does the data support the proposition that motorcycle helmet laws reduce motorcycle accident fatalities?